Derivatives Flashcards
Contingent claim
A contingent claim is a claim (to a payoff) that depends on a particular event. (e.g. options, credit default swaps etc)
Settlement price for futures contracts
The settlement price is an average of the prices of the trades during the last period of trading, called the closing period, which is set by the exchange. This specification of the settlement price reduces the opportunity of traders to manipulate the settlement price. The settlement price is used to calculate the daily gain or loss at the end of each trading day. On its final day of trading the settlement price is equal to the spot price of the underlying asset (i.e., futures prices converge to spot prices as futures contracts approach expiration).
Open interest
The number of futures contracts of a specific kind (e.g., soybeans for November delivery) that are outstanding at any given time is known as the open interest. Open interest increases when traders enter new long and short positions and decreases when traders exit existing positions.
law of one price
Two securities or portfolios that have identical cash flows in the future, regardless of future events, should have the same price. If A and B have the identical future payoffs and A is priced lower than B, buy A and sell B. You have an immediate profit, and the payoff on A will satisfy the (future) liability of being short on B.
convenience yield
Non-monetary benefits of holding an asset are sometimes referred to as its convenience yield. The convenience yield is difficult to measure and is only significant for some assets, primarily commodities.
cost of carry
The net cost of holding an asset, considering both the costs and benefits of holding the asset, is referred to as the cost of carry.
Moneyness
Moneyness refers to whether an option is in the money or out of the money.
If immediate exercise of the option would generate a positive payoff, it is in the money.
If immediate exercise would result in a loss (negative payoff), it is out of the money.
When the current asset price equals the exercise price, exercise will generate neither a gain nor loss, and the option is at the money.
put call parity
The put-call parity is the relationship that exists between put and call prices of the same underlying security, strike price, and expiration month. The put-call parity is important because it eliminates the possibility of arbitrage traders making profitable trades with no risk.
Our derivation of put-call parity for European options is based on the payoffs of two portfolio combinations: a fiduciary call and a protective put.
